The life cycle hypothesis explains the long run constancy of the savings rate and short run variability of savings rate provided
A)the proportions of working and retired people are constant in each historical era.
B)the saving behavior of each age group does not change from generation to generation.
C)A and B are both required to explain the apparent contradiction.
D)Friedman's PIH is in error.

Question

Quizplus · Accepted Answer

Both factors are necessary to explain the constancy of the savings rate in the long run and the variability of the savings rate in the short run. The life cycle hypothesis assumes that individuals plan their savings over their lifetime based on their expected income and consumption needs. Therefore, changes in the proportions of working and retired people or changes in saving behavior across generations would affect the overall savings rate.

The Life Cycle Hypothesis Explains the Long Run Constancy of the Savings